Most Everything You've Heard about China's Currency is Dead Wrong (and that Means Money for Us)

Your email address will not be published. Required fields are marked *

Comment

Some HTML is OK

Sign me up for the Money Morning newsletter

Name *

Email *

Website

1 + = 10

Nearly everything you've heard about China's currency, the yuan, is dead wrong. It's not undervalued and it's not undercutting the U.S. dollar as the financial press and politicians like to point out. I'll show you why.

You likely heard that China recently reported it had grown just 7.5 percent in the second quarter of 2013, the lowest level in over three years.

China uses government investments as the main channel to pump money into its economy. The resulting monetary growth makes the Fed's quantitative easing seem like child's play.

Another thing – a very important thing – you likely haven't heard is on a purchasing power parity basis, the Chinese Yuan is overvalued – not undervalued – versus the U.S Dollar.

The Yuan used to be a cheap currency before 2008, but this changed after the Chinese government responded to the global recession with massive stimulus investment spending. Driven by the greatest construction spree in history, Chinese banks lent out trillions and the country's money supply grew three times as fast as the U.S.

Unlike the Fed, the Chinese central bank can order commercial banks to lend money and directly pump liquidity into its economy.

For five years, Chinese banks recklessly lent money to local governments and other state-owned enterprises, enriching government officials, bankers and state-owned enterprise managers in the process.

$3 Trillion in Funny Money

Investment lending, corruption and spending spiraled out of control. China spent $3 trillion on investments, and the funny money caused real estate prices to triple and inflation to skyrocket.

Even though the U.S economy is about twice the size of China's, the Asian giant's M2 money stock is 70% greater than the U.S.

Just in Q1 of this year, credit expanded by $1 trillion in China, equivalent to an entire year's Fed quantitative easing. Yet despite excessive money creation, the Chinese Yuan rose 9% against the dollar since 2008, making the Yuan more overvalued.

Inflation: China Style

China's monetary excess fueled its investment bubbles and inflation, both were worsened by the fact that newly created Yuan is not freely traded and largely trapped in the country.

The Yuan lost over 60% of its purchasing power in the past five years. To prevent purchasing power from eroding, Chinese investors bought all sorts of real assets, from fine wine, jade, real estate to gold,

If you want to see evidence of the Yuan's over-valuation, just go to any major high-end department store in New York or Los Angeles, where you will see droves of Chinese tourists stocking up on Louis Vuitton and Coach bags faster than canned goods before a zombie attack in the movie World War Z.

According to the U.S. Office of Travel and Tourism Industries, Chinese tourists spend an average of $2,932 per visit to California, compared with $1,883 for other overseas visitors because the Chinese know that their Yuan, when converted into cheap U.S dollars, goes a lot further here.

Because of rampant inflation, just about anything that is high quality in China costs more there than in the U.S.

In Shanghai, where my money management company has an office, the cost of office rents, laptops, clothing, sneakers, cellphones, talented professionals, cars, wine, coffee, etc. is usually 20% to 200% higher than in Los Angeles. This is true even for branded goods, such as Nike sneakers and HP laptops that are made in China.

You can buy cheaper unbranded goods produced by local Chinese companies, as most of the less affluent locals do, but the quality is usually shoddy. For instance, Chinese branded AA batteries for my electric toothbrush usually last only a few days, while Duracell batteries usually last for months.

Politics Trump Economics

Although the Yuan is overvalued, I wouldn't bet against it just yet. Because of currency control, Dollar-Yuan exchange rates are driven by politics rather than economics. Political pressure from Washington prevents the Yuan from losing ground against the dollar for now.

Long term, though, contrary to what many U.S politicians claim, a Yuan that loses purchasing power will depreciate against the U.S dollar.

That's why investments, not exports, drive China's economic growth. The most recent data shows Chinese exports are down 3.1% year-over-year while total GDP rose by 7.5%, mostly from investment growth.

Investments make up a greater percentage of Chinese GDP growth than exports and domestic consumption combined.

A few weeks ago, Beijing forced banks to curtail investment lending and caused a liquidity crunch in China. Cutting back on investment spending will cause GDP growth to slow even more, but it beats massive inflation and debt default.

Investors need to prepare for a slower growing China.

Avoid investing in resource countries that rely on Chinese commodity purchases for economic growth, such as Canada, Brazil and Australia. You should also watch out for any potential fall-out from the coming China bubble deflation.

The world's No. 2 economy will remain an important force and should be on everyone's radar screen.

But for now, when it comes to investments, focus on the world's No. 1 economy right here at home. The Fed's easy money policy won't end anytime soon and robust earnings will drive stocks higher.

Robert also guides you to the right way to look at investing for retirementhere. It's to look beyond wealth preservation and to actively manage your portfolio.

Interesting article, but even more interesting is that everything I know about China's currency came from Money Morning Chief Investment Strategist Keith Fitz-Gerald, and if that is dead wrong… I'd like to see Keith's taking and follow up on this article.

Interesting write as it does confirm how the U.S. is causing inflation overseas. Now with that thought I did not read how a band of countries commonly called BRIC want to stop this inflation by creating a gold standard removing the dollar as the global currency. China has been scooping up the gold and encourages its people to buy it too. If gold becomes the defacto over the dollar a wealth transfer will happen for China ending its bubble for sure. The next G20 Sept4/5 in Russia will be very interesting. I really dont get why this happening is being kept in the Dark over here. When this happens the market will drop like a rock worse than 2008.

The yuan has been appreciating against the dollar constantly since 2010 (6.8 yuan in 2010, 6.14 today, about 10%). The cinese had to follow the Bernanke printing press to avoid an even greater yuan appreciation which would have killed their exports to the US. Indeed this is the exporting of American inflation to the rest of the world. Soon this inflation will come back to the US resulting in hyperinflation here. Protect yourself now and buy as much possible gold and silver!!!

China is going to a Gold backed Yuan , And the US Dollar is going down !!! This has been several years in the planning. China has been buying gold, US businesses and Real estate With the bloated US Dollar. And devalued its currency to a level it can be Gold backed, And will take over as the World currency to hold. (International banking wants a standard exchange rate which will be a gold backed currency)

By submitting your email address you will receive a free subscription to Money Morning and receive Money Morning Profit Alerts. You will also receive occasional special offers from Money Map Press and our affiliates. You can unsubscribe at anytime and we encourage you to read more about our privacy policy.

You can view our VQScore top-rated stocks now by entering your email below:

By submitting your email address you will receive a free subscription to VQScore and occasional special offers from Money Map Press and our affiliates. You can unsubscribe at anytime and we encourage you to read more about our privacy policy.

Today's Markets

DJIA82.66(0.35%)23,675.64

NASDAQ30.18(0.45%)6,783.91

S&P0.21(0.01%)2,546.16

ABOUT MONEY MORNING

Money Morning gives you access to a team of ten market experts with more than 250 years of combined investing experience – for free. Our experts – who have appeared on FOXBusiness, CNBC, NPR, and BloombergTV – deliver daily investing tips and stock picks, provide analysis with actions to take, and answer your biggest market questions. Our goal is to help our millions of e-newsletter subscribers and Moneymorning.com visitors become smarter, more confident investors.

By submitting your email address you will receive a free subscription to Money Morning and receive Money Morning Profit Alerts. You will also receive occasional special offers from Money Map Press and our affiliates. You can unsubscribe at anytime and we encourage you to read more about our privacy policy.